When in need of funding, many small businesses turn to term loans. However, it is important to figure out which one is right for your business.
Business term loans are a broad type of business loan where a borrowing business typically collects a lump sum from a lender and repays the funds over the time specified in the agreed upon terms. Usually, terms can range from as little as a few months to as long as ten or more years, and the rates and length of the terms are determined by the strength and stability of the borrowing business, their credit strength, and the extent of their expense needs.
Typically, if the borrowing business can put up collateral to secure the funds, the lender will offer more beneficial terms and lower rates. Examples of collateral that a borrowing business can use to secure a business term loan are accounts receivable/invoices, equipment, inventory, and real estate.
The specific details and terms of different loan products vary by lender and based on the nature of the borrowing business’s needs. There are five common types of business term loans: bridge term loans, multi-year term loans, SBA term loans, asset-based term loans and equipment term loans. Here is a breakdown of each option.
Bridge term loans
A bridge loan is a specific type of business term loan that is designed to meet immediate, short-term financing needs for business owners. Repayments for a bridge term loan are typically short, with payments being made to the lender on a weekly, bi-monthly, or monthly basis, and because the lenders typically understand the urgency of the short-term nature of the need for funds, capital can be wired to borrowing businesses within 24 hours of application in many cases.
The most important consideration when applying for a bridge term loan is the cash flow available to the borrowing business in the near future, which will be necessary to support the term payments for the bridge loan. Since the repayment is short-term, borrowing businesses will need to demonstrate to the lender that they will be able to make their payments quickly.
Multi-year term loans
Multi-year term loans are business term loans with repayment schedules that typically last two to five years. This type of term loan, amortizing over several years, often offers business owners lower monthly payments to stretch out the cost and improve the working capital available for daily operation.
In order to qualify for a multi-year term loan, borrowing businesses need to demonstrate strong credit, consistent cash flow, and the business owner should be able to show that they have strong personal credit. The application process for multi-year term loans is easier than SBA or asset-based lending programs, requiring less paperwork and consisting of fewer requirements. Borrowing business owners will need to present financial information, tax returns, and other documents to give the lender the opportunity to review the financial risk the borrower will impose.
SBA term loans
The Small Business Administration established its SBA term loan programs in order to provide assistance to small business owners who are trying to secure funding. By providing a guarantee to SBA-approved lenders, more small business owners can obtain funding, as the lenders have a large percentage of the funds backed by the SBA. The biggest benefits that SBA term loans offer business owners are long payment terms, low interest rates and large available loan amounts.
There are multiple types of SBA term loan programs available for small business owner, differing by the type of expense the funds are utilized for. There are SBA term programs for purchasing inventory or equipment, consolidating existing debt, purchasing real estate, or other working capital needs.
Asset-based term loans
Many business owners find themselves in situations where working capital isn't enough to show a lender they will be able to make the payments over the terms of their business term loan. Lenders want to reduce their risk when giving out money to business owners, and if a business does not look like they will be able to make their payments, one other option is to use collateral to secure the funds. Asset-based term loans use collateral, valuable assets that the borrowing business can show to the lender, then in the event of a default, if the borrower cannot make their payments, the lender will claim the asset. Terms and conditions for different asset-based term loan programs differ from lender to lender and will vary based on the type of collateral, the value of the assets, the amount borrowed, and the length of the term.
Some examples of different types of collateral that can be used to secure asset-based lending programs include accounts receivable or invoices, valuable inventory, equipment or machinery, real estate, intellectual property, or marketable securities. Not all assets are valued the same by lenders, and the value that a borrowing business puts on the asset might not be the same value that the lender puts on the asset. The lender will evaluate the value of assets based on the amount they would be able to liquidate them for in the case that the borrower defaults on their payments. Accounts receivable, inventory, and equipment are the types of assets that lenders typically value the highest, as these are the easiest types of collateral for the lenders to re-sell or capitalize on. Other types of assets are not liquidated easily and most likely cannot be used to secure the majority of a business term loan, but might be considered for additional capital.
Asset-based term loans are generally utilized most by business-to-business industries because these types of companies more often have higher values in assets compared to most business-to-consumer companies. Manufacturing companies rely on extremely valuable equipment, which can be used to secure financing, and B2B companies often deal with accounts receivables and invoices, inventory, and large quantities of materials, compared to a B2C business that might only use furniture, small equipment, and fixtures available for collateral. Compared to other types of lending options, asset-based term loans typically require more paperwork and documentation. Specifically, borrowing businesses will have to provide a financial demonstration that the business has good fiscal health, has a good credit history, and evidence of the value of the assets. Additionally, a majority of lenders include a field audit as a part of the underwriting process to evaluate the worth of the assets being used for collateral.
Equipment term loans
A final type of business term loan available are equipment term loans, utilized for financing the entire cost of new or used equipment. When business owners need to buy new machinery, vehicles, or other types of equipment needed, using a business term loan allows them to extend the burden of the payments over the course of the term length, rather than making expensive purchases up front.
Maintaining the right equipment to provide effective productivity means putting the right tools in place, but the costs add up quickly. Using equipment term loans frees up capital and other lines of credit that can be utilized for other costs in the future. For "small ticket" items under $250,000, funds can often be wired within 24 hours, however for "big ticket" items over $250,000, the lender will often need to perform a full financial check to determine the borrowing business’ eligibility.
These term loans are structured as either equipment loans or equipment leasing programs, which both can be used in any industry. If the equipment is necessary for operation, an equipment term loan can most likely cover the expense to allow business owners the opportunity to obtain the best equipment possible. Equipment loans involve receiving a lump sum of funds from a lender for the purchase of the equipment, where the borrowing business makes payments until the balance is paid off. For equipment leases, the leasing company covers the cost of the equipment up-front, and the borrowing business makes payments over the terms of the lease. At the end of the terms, the borrowing business can either give back the equipment, extend the terms to continue making payments and use the equipment, or take the option to buy the equipment outright.